Cryptocurrency Explained With Pros and Cons for Investment

What exactly is cryptocurrency?

It is a new age encrypted digital or virtual currency to avoid counterfeiting or double-spending. They are immune to political influence or manipulation because they are typically not issued by a central body. They allow for secure online payments without the need for third-party intermediaries. Cryptographic algorithms and encryption methods used to protect these entries, such as elliptical curve encryption, public-private key pairs, and hashing functions, are referred to as Crypto. Although bitcoin can be mined or acquired on cryptocurrency exchanges, all online shops and platforms do not accept cryptocurrency payments.

Where does blockchain come into play?

A blockchain, as the name implies, is a collection of linked blocks or an online ledger. Each block is made up of an array of transactions that have been confirmed by each network member individually. Each node must check each new block before it can be confirmed, making faking transaction histories extremely difficult. The contents of the online ledger must be agreed upon by the complete network of a single node or computer holding a copy of the catalogue.

According to market experts, blockchain technology can disrupt many businesses, including supply chains, online voting, and crowdfunding. JPMorgan Chase & Co. (JPM) is looking into using blockchain technology to cut transaction costs by speeding up payment processing.

How are they distinguished?

The term "cryptocurrencies" refers to all sorts of cryptocurrencies or digital currencies, and the terms "coins" and "cryptocurrencies" are sometimes used interchangeably. Keeping that in mind, these are the categories into which the cryptocurrency has been classified:

• Coins: It differs from altcoins in that it is built on its own blockchain. They often serve as the native token. The creation of a blockchain precedes or is connected with the development of a cryptocurrency. Some common examples of coins include Bitcoin and Litecoin.
• Altcoins: Although they are coins, all of them are viewed as alternative cryptocurrencies to Bitcoin, the original cryptocurrency. Aside from Ethereum, the majority of the first altcoins forked from Bitcoin.
• Tokens: They are digital representations of a particular item or service. They are intended to enable smart contracts on blockchain networks like Ethereum. Tokens are built into self-executing computer programmes or algorithms. They are also fungible and tradeable. They might be points, commodities, or even other cryptocurrencies.

The developer must follow a set pattern when developing or coding a token. The developer must not update or code the blockchain from scratch; instead, they must follow a consistent template. It is simpler to create a token.

Are they completely legal?

As the world is evolving at a breakneck pace, the Cryptocurrency market is catching up. An excellent example is fiat currency, backed by the government or monetary authority. Each $1 note, for example, is supported by the Federal Reserve. However, the scene for cryptocurrency is slightly different based on various economic infrastructures.

The Japanese Payment Services Act proclaims Bitcoin to be legal property. Nationally, cryptocurrency exchanges must collect client information and wire transfer data. China has outlawed bitcoin trading and mining within its borders. In recent years, India was believed to be thinking of a cryptocurrency framework. This mindset shows that bitcoin's legal status could be subject to certain regulations in India.

Although cryptocurrencies are considered money, the Internal Revenue Service (IRS) classifies them as financial assets or property. Like most other assets, the government wants a cut of any profits from selling or trading cryptocurrency. On May 20, 2021, the US Department of Treasury issued a proposal requiring taxpayers to report all bitcoin transactions worth $10,000 or more to the IRS.

Are cryptocurrency investments risky?

Cryptocurrencies have developed a reputation as risky investments due to massive losses caused by fraud, hacking, and faults. While the underlying encryption is generally secure, unskilled users may face considerable risks due to the technical intricacy of using and storing crypto assets. In addition to the risks inherent in speculative investments, investors should be mindful of the following potential risks:

Regulatory Risks

Several cryptocurrencies' legal status is still being contested, with numerous nations seeking to classify them as securities, currencies, or both. An unanticipated governmental crackdown might make it harder to sell cryptocurrency or result in a market-wide price drop.

User Risk

Unlike conventional finance, a bitcoin transaction cannot be reversed or cancelled after delivery. Based on the most recent estimates, one-fifth of all bitcoins are lost by users due to forgetting passwords or incorrect transmission addresses.

Counterparty Risks

Many investors and merchants keep their cryptocurrencies in the custody of exchanges or other third-party custodians. Theft or damage to one of these third parties can result in the complete loss of one's investment.

Management Risks

Due to a lack of established norms, there are few safeguards against fraudulent or unethical management practices. Various new investors have lost significant sums due to management teams' failure to develop a product.

Programming Risks

Several investments and lending companies use automated smart contracts to manage consumer deposit transfers. An investor who has relied on one of these platforms acknowledges the risk of losing money if one of these programmes has a bug or weakness.

Market Manipulation Risks

While this does not happen regularly, it is a big issue in cryptocurrency. Every now and then, there will be reports of individual exchanges being accused of price manipulation or trading against their customers.

What are its advantages and disadvantages?

The following are some of the advantages and disadvantages of cryptocurrencies:

Advantages

• They represent a new, decentralized money paradigm. As a natural outcome, a cryptocurrency-based system reduces the likelihood of a single point of failure, such as a huge bank, triggering a global disaster, such as the one produced by the United States' 2008 financial crisis.
• They efficiently facilitate money transactions between two people by removing the need for a third party, such as a bank or credit card provider. Public and private keys and other incentive systems, such as proof of labour or proof of stake, secure these decentralized transactions.
• They can be sent between two transacting parties faster than typical money transfers because they do not need third-party middlemen. Flash loans are a great example of decentralized transactions in decentralized finance. These unsecured loans can be completed in seconds and used in trading.
• They can be used as investments since they are highly profitable. Over the last decade, the value of cryptocurrency markets has surged tremendously, reaching more than $2 trillion and still rising.
• Bitcoin and other cryptocurrencies act as intermediary currencies for cross-border transfers. As a result, fiat currency is converted to Bitcoin or another cryptocurrency and sent across borders before being converted back to the original fiat currency. This method simplifies and lowers the costs of money transfers.

Disadvantages

• Despite their promise of being an anonymous means of exchange, cryptocurrencies are pseudonymous. They leave a digital trail that various major investigation organizations can decipher. This allows governments or federal authorities to track ordinary people's banking transactions.
• Criminals increasingly use cryptocurrency for undesirable objectives such as money laundering and illicit purchasing. Dread Pirate Roberts, who managed a drug trafficking enterprise on the dark web, is a well-known example. Cryptocurrencies have also grown in popularity with hackers, who use them to launch ransomware assaults.
• Cryptocurrencies are designed to be decentralized, with their value distributed among multiple parties via a blockchain. Ownership is highly concentrated in practice. According to an MIT study, only 11,000 people held over 45% of Bitcoin's skyrocketing value.
• It is widely assumed that anyone with a computer and an Internet connection can mine cryptocurrency. On the other hand, popular mining cryptocurrencies require a substantial amount of energy, possibly as much as entire countries spend. Due to high energy costs and the industry's unpredictability, mining has been concentrated among large firms with billions of dollars in income.
• Price volatility has an impact on cryptocurrencies traded on public exchanges. As popular as Bitcoin is, its value has fluctuated drastically, reaching a high of $17,738 in December 2017 before plunging below $7,575 in the following months. As a possible consequence, some economists feel that cryptocurrencies are only a passing fad or speculative bubble.

Are cryptocurrencies considered securities?

According to the Securities and Exchange Commission (SEC), Bitcoin and Ethereum, the two most valued cryptocurrencies in market capitalization, are not securities. Initially, SEC's chair, named Gary Gensler, declared cryptocurrencies to be securities in September 2022 and directed SEC staff to begin working with cryptocurrency developers to register their coins. However, he later clarified that he was speaking for himself, not on behalf of the SEC. He urged newcomers to the crypto space to register their coins immediately since "it's substantially less expensive to do it right away".

The Bottom Line

Cryptocurrencies are digital assets that are encrypted for security. But because they are a new technology, they are very speculative, and it is vital to understand the risks before investing. Nonetheless, the world is evolving quicker, cryptocurrency will catch up, and people will finally make decisions based on them. In terms of investing, cryptocurrencies are risky, and one should learn everything they possibly can before seriously investing in them. Because every individual's situation is different, it is always better to consult a competent specialist before making any financial decisions.